Friday, July 7, 2017

What's good about economics (sometimes)

Bryan Caplan has a nice post at ecconlib. The last part is an ode to the value of simple economic theory, much disparaged in public debate.

Bryan's central point: Economic theory lets you vastly broaden the range of experience that you can bring to one question -- the effect of minimum wages in Seattle, for example. Economic theory also forces logical consistency that would not otherwise be obvious. You can't argue that the labor demand curve is vertical today, for the minimum wage, and horizontal tomorrow, for immigrants. There is one labor demand curve, and it is what it is. Economics lets one experience illuminate the other, and done right forces politically uncomfortable consistency on those views. You can't argue that sticky too-high wages cause unemployment in recessions and in Greece, and not argue that sticky too-high wages from minimum wages laws do not cause unemployment in Seattle.

This kind of integrated thinking is far too rare in evaluating economic policies. But that's the fault of economists, not of economics.

Bryan:

Research doesn't have to officially be about the minimum wage to be highly relevant to the debate. All of the following empirical literatures support the orthodox view that the minimum wage has pronounced disemployment effects:

1. The literature on the effect of low-skilled immigration on native wages. A strong consensus finds that large increases in low-skilled immigration have little effect on low-skilled native wages. David Card himself is a major contributor here, most famously for his study of the Mariel boatlift. These results imply a highly elastic demand curve for low-skilled labor, which in turn implies a large disemployment effect of the minimum wage.

This consensus among immigration researchers is so strong that George Borjas titled his dissenting paper "The Labor Demand Curve Is Downward Sloping." If this were a paper on the minimum wage, readers would assume Borjas was arguing that the labor demand curve is downward-sloping rather than vertical. Since he's writing about immigration, however, he's actually claiming the labor demand curve is downward-sloping rather than horizontal!

2. The literature on the effect of European labor market regulation. Most economists who study European labor markets admit that strict labor market regulations are an important cause of high long-term unemployment. When I ask random European economists, they tell me, "The economics is clear; the problem is politics," meaning that European governments are afraid to embrace the deregulation they know they need to restore full employment. To be fair, high minimum wages are only one facet of European labor market regulation. But if you find that one kind of regulation that raises labor costs reduces employment, the reasonable inference to draw is that any regulation that raises labor costs has similar effects - including, of course, the minimum wage.

3. The literature on the effects of price controls in general. There are vast empirical literatures studying the effects of price controls of housing (rent control), agriculture (price supports), energy (oil and gas price controls), banking (Regulation Q) etc. Each of these literatures bolsters the textbook story about the effect of price controls - and therefore ipso facto bolsters the textbook story about the effect of price controls in the labor market.

If you object, "Evidence on rent control is only relevant for housing markets, not labor markets," I'll retort, "In that case, evidence on the minimum wage in New Jersey and Pennsylvania in the 1990s is only relevant for those two states during that decade." My point: If you can't generalize empirical results from one market to another, you can't generalize empirical results from one state to another, or one era to another. And if that's what you think, empirical work is a waste of time.

4. The literature on Keynesian macroeconomics. If you're even mildly Keynesian, you know that downward nominal wage rigidity occasionally leads to lots of involuntary unemployment. If, like most Keynesians, you think that your view is backed by overwhelming empirical evidence, I have a challenge for you: Explain why market-driven downward nominal wage rigidity leads to unemployment without implying that a government-imposed minimum wage leads to unemployment. The challenge is tough because the whole point of the minimum wage is to intensify what Keynesians correctly see as the fundamental cause of unemployment: The failure of nominal wages to fall until the market clears.

9 comments:

The practice of selective citation of studies to prove inconsistent points makes think of a couple of thing:

1. Posner's point that a liberal arts education probably won't make a person more virtuous, because it may just teach him a broader menu of options from which to pick his rationalizations for evil behavior. The common man just knows a few philosophies, and picks one, in which he feels he ought to live consistently.

2. The conservative religious practice of picking Biblical proof texts rather than using systematic theology, in which inconsistencies are more easily exposed.

My own field of theoretical IO is of course notorious for this; we can find a theory for any isolated observation you have.

I agree with this post…but egads, how we can condemn rent control and not mention property zoning?

If the supply of housing in a region is artificially constrained through zoning, then voters are probably "justified" in voting in rent controls.

I have a better idea: Let the Byran Caplans, the John Cochranes, the Mark Perrys and hopefully many more wage jihad on property zoning. Property zoning is probably the largest structural impediment in the nation today.

I will take it even further: If the propertied-financial class extracts rent though restrictive property zoning, is not employee-class justified in seeking minimum wages and rent control?

What makes some artificial structural impediments worthy of mention, and others…well, not a topic?

Side note: Immigration of low-skill labor and no effect on wages.

Maybe so, but supply and demand? Economic theory?

So, we believe in empirical results when convenient, but not when inconvenient?

"If you object, "Evidence on rent control is only relevant for housing markets, not labor markets," I'll retort, "In that case, evidence on the minimum wage in New Jersey and Pennsylvania in the 1990s is only relevant for those two states during that decade."

This assumes that all markets are identical, which is obviously wrong. Or, an upper price ceiling I.e rent controls are identical to lower price floors in their effects I.e minimum wages.

If that were true, empirical work would indeed be pointless because you could see the results in one market and guess the results of every other market on the planet.

Luckily, the world and economics is more interesting than that - minimum wages have consistently shown to raise wages for the poor up to a point (including in that Kansas study to $11 an hour).

Keynesian economics -- at least, the economics I read in the General Theory -- does not rely on sticky nominal wages. In Chapter 3, part II, Keynes is quite explicit about this. Indeed, he later argues that sticky nominal wages would help, not hinder efficiency. Krugman has made reference to this point several times. People really need to get up to speed here.

"fundamental cause of unemployment: The failure of nominal wages to fall until the market clears."

Agreed. On a macro scale with long term nominal debt contracts, declining nominal wages do not necessarily result in full employment. The opposite can easily be understood if falling wages contribute to declining nominal GDP. Plus, nominal wage is secondary to the importance of real wages. Full employment is more likely to be achieved under conditions of rising NGDP & nominal wages even if real wages decline.

"fundamental cause of unemployment: The failure of nominal wages to fall until the market clears."

Agreed. On a macro scale with long term nominal debt contracts, declining nominal wages do not necessarily result in full employment. The opposite can easily be understood if falling wages contribute to declining nominal GDP. Plus, nominal wage is secondary to the importance of real wages. Full employment is more likely to be achieved under conditions of rising NGDP & nominal wages even if real wages decline.

The empirical studies have taken the center stage in economics as it may be triggered for multiple reasons like i) analysis of a public policy ii) testing a hypothesis in a economic policy iii) deeper understanding of micro or macro agents; are few to name.While the theoretical studies allow to formulate some basic assumptions and questions about a economic model, the empirical studies allows to dig deeper a specific aspect with carefully curated data set. The role of theoretical studies is important as many economic situations are extremely complex and in many cases extracting the right data set may be very intensive if not impossible. Another advantage of theoretical studies is their flexibility to consider many constraints simultaneously without worrying about extent of relationship among them.While theoretical studies provides the basic framework for understanding, given the complex nature of economic model, for a practical implementation of any public policy it is important to understand the inter relationship among various factors. Empirical studies allow to study the correlation and apply learning of one situation to another situation.For me the take away from Bryan Caplan’s post is:"If you object, "Evidence on rent control is only relevant for housing markets, not labor markets," I'll retort, "In that case, evidence on the minimum wage in New Jersey and Pennsylvania in the 1990s is only relevant for those two states during that decade." My point: If you can't generalize empirical results from one market to another, you can't generalize empirical results from one state to another, or one era to another. And if that's what you think, empirical work is a waste of time."

The empirical studies have taken the center stage in economics as it may be triggered for multiple reasons like i) analysis of a public policy ii) testing a hypothesis in a economic policy iii) deeper understanding of micro or macro agents; are few to name.While the theoretical studies allow to formulate some basic assumptions and questions about a economic model, the empirical studies allows to dig deeper a specific aspect with carefully curated data set. The role of theoretical studies is important as many economic situations are extremely complex and in many cases extracting the right data set may be very intensive if not impossible. Another advantage of theoretical studies is their flexibility to consider many constraints simultaneously without worrying about extent of relationship among them.While theoretical studies provides the basic framework for understanding, given the complex nature of economic model, for a practical implementation of any public policy it is important to understand the inter relationship among various factors. Empirical studies allow to study the correlation and apply learning of one situation to another situation.For me the take away from Bryan Caplan’s post is:"If you object, "Evidence on rent control is only relevant for housing markets, not labor markets," I'll retort, "In that case, evidence on the minimum wage in New Jersey and Pennsylvania in the 1990s is only relevant for those two states during that decade." My point: If you can't generalize empirical results from one market to another, you can't generalize empirical results from one state to another, or one era to another. And if that's what you think, empirical work is a waste of time."

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About Me and This Blog

This is a blog of news, views, and commentary, from a humorous free-market point of view. After one too many rants at the dinner table, my kids called me "the grumpy economist," and hence this blog and its title.
In real life I'm a Senior Fellow of the Hoover Institution at Stanford. I was formerly a professor at the University of Chicago Booth School of Business. I'm also an adjunct scholar of the Cato Institute. I'm not really grumpy by the way!